Saudi Demands Higher Production Ceiling

Saudi's Oil Minister Ali al-Naimi, started the fireworks ahead of the OPEC meeting by calling for a higher production quota saying "there was a need for a higher ceiling than currently exists."

"Saudi Arabia would like an official increase in quota as having actual production massively over the official quota is not good for the credibility of the organization," according to Olivier Jakob, Managing Director of Petromatrix.

Demand for refined products rose slightly last week as the summer driving season escalates but imports also rose and inventories remained mostly level. Prices are still under pressure from a slowing European economy and uncertainty over Greece, Spain, Iran and OPEC.

Crude inventories declined for the second week but it was minimal. The EIA reported a -200,000 barrel decline in crude inventories after an even smaller -100,000 barrel drop last week. This decline came despite a sharp increase in refinery utilization to 92% and the highest in nearly a year and a jump of +180,000 bpd in imports to 9.12 mbpd and the highest level in months. U.S. production declined by 10,000 bpd.

Gasoline demand surged +482,000 bpd to 9.13 mbpd and the highest level this year. This is still below the 9.37 mbpd for the same week in 2011. This surge in demand caused a -1.7 million barrel drop in inventory levels. Imports declined -152,000 bpd. Gasoline inventory levels are still -6.2% below year ago levels despite a rise of 3.3 million barrels in the prior week.

Distillates declined by only -100,000 barrels. The prior week there was a gain of +2.3 million. Distillate demand rose by +310,000 bpd but the week to week numbers have been volatile and suggest a hiccup in the reporting process.

I am encouraged by the seasonal pickup in demand. For a while there it appeared we were headed for another rocky summer but the increase in demand suggests consumers are just being cautious with prices still in the $3.55 range for gasoline. The longer it stays in that range the more accustomed consumers will become with paying the price and the next leg higher won't be so damaging.

Inventories at Cushing failed to set a new record with a decline of -400,000 barrels. The Seaway Pipeline delivered its first load of oil to the coast and is now in full operation. This will remove another one million barrels a week from the Cushing backlog. Once the initial pipeline upgrades are completed that will rise to 2.8 million barrels. An even larger upgrade is planned for 2014.

Inventory Snapshot

Crude Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

The fall in crude prices in May have prompted the various agencies to lower their target price for crude oil in 2012. The EIA cuts its forecast for the rest of the year to an average of $95 for WTI compared to the $105 predicted earlier in the year. That assumes the economic conditions in Europe and the USA do not deteriorate further and OPEC does not cut production. The EIA is still expecting a global increase in demand of 1.8 mbpd for 2012. They also expect supplies to tighten as the summer progresses and the Iranian sanctions to increase.

The next meeting between Iran and the six UN nations is scheduled for June 18th. The outlook is not good. Iran says the UN position is too one sided and Iran will not give up enrichment to either higher or lower levels and they refuse to let the IAEA inspect the Parchin military base. Iran said it is bringing its own five point proposal to the Moscow meeting. That proposal includes pledges from the UN nations to stay out of the Syrian conflict and cancel the pending oil embargo while the parties continue to negotiate.

Clearly the UN nations and the EU are not going to cancel the implementation of the embargo because that is the only reason Iran is even taking part in the talks. In the past Iran tried to drag out the process as it is doing today by bringing issues to the table that have nothing to do with the topic. In the interest of cooperation the UN nations have to listen and debate the topics. This takes up time and prevents serious discussions on the real problem. Iran can claim they came willing to negotiate but the UN nations were being unreasonable. This gives them a face saving response when the meeting ends without any resolution.

I said "clearly" the UN is not going to cancel the implementation of the embargo and sanctions. I should have said I hope the UN is not dumb enough to fall for the trick again and postpone Iran's day of reckoning.

The IEA said on Wednesday that Iran's exports have fallen by 40% since January. The IEA said preliminary indications suggest exports fell to 1.5 mbpd in May, down from 2.5 mbpd in December. The agency believes Iran is still producing its 3.3 mbpd but is stockpiling the excess oil. If the embargo is successful Iran will have to start shutting down production when it runs out of storage space.

There is mounting evidence even Iran's biggest customers including China and India are slowing purchases because of heavy pressure from Washington. However, Secretary Clinton announced an exemption for India because of its heavy reliance on Iranian grades of crude. The government said on Monday that India, South Korea, Japan and Turkey have made significant cuts to purchases from Iran.

On July 1st the EU embargo and sanctions will cut off insurance for tankers and that will stop critical shipments to Asia where London based insurers underwrite the cargos.

The IEA is expecting significantly less demand growth in 2012 at +820,000 bpd compared to the EIA at 1.8 mbpd. The IEA does believe the "call" on OPEC for the second half of the year will remain in the 31.0 mbpd range and 1.0 mbpd higher than the official OPEC quota. OPEC claims to have produced 31.75 mbpd in May.

An OPEC report released on Wednesday said April production was 32.964 mbpd. This is +631,000 bpd higher than their prior claims and well over the 30.0 mbpd quota. This is why we need to take the reported 31.75 mbpd claim for current production as potentially misleading.

On Thursday OPEC meets in Vienna and the whiner nations have already started their campaign to cut production in order to raise prices. Those nations include Iran, Venezuela, Algeria, etc. They are already producing all they can so they can't gain any more revenue by increasing production. Their only hope is to get everyone else to cut production so the whiners can get more for their oil. I would do the same in their position.

Saudi Arabia is lobbying for a higher quota and is not likely to agree to any reduction in output in order to keep the market flooded with oil and allow the sanctions to increase on Iran. This is an economic war between Saudi and Iran. There are rumors that Saudi Arabia and the White House have conspired to increase pressure on Iran in return for continuing the highest production in Saudi Arabia in decades in order to produce lower gasoline prices in an election year.

The falling oil prices are good for the U.S. and Europe but bad for the Middle East and Northern Africa. Analysts are starting to cut their economic growth estimates for those regions by about 25% because of the lack of funds. HSBC claims Saudi Arabia has a breakeven price for crude oil at $76 while other recent articles claim that has risen to $98 because of the $200 billion in social programs announced to keep the Arab Spring at bay in Saudi Arabia. The UAE needs oil above $86 per barrel.

Every decline in price above those levels reduces the amount of excess cash flow the governments have for new spending on things like infrastructure and expansion. It also reduces the amount of additional exploration they can fund. Eventually that will push prices higher but it is a lengthy process.

Iran is currently running at a +0.3% GDP and a cut or 1.0 mbpd in exports could subtract -2.0% and put them into recession. They are already seeing inflation rampant with food inflation up as much as 25% as a result of the sanctions. Change is coming to Iran whether they want it or not.

The price of crude continues to be at risk to the events in Greece and their impact on Europe. Sunday is the Greek vote and the last poll showed the two major candidates neck and neck. Greek law forbids polls in the two weeks before an election so we have to wait and see for the results on Monday. A pro-austerity party win would be beneficial for European demand assumptions while an anti-austerity win would send the region into a deeper funk and potential trillions in losses from a Greek exit from the euro.

Spain is the next domino with Cyprus and Italy not far behind. Italy has a bond auction on Thursday and should that not go well we could see another market decline. There is not enough money in Europe to bailout Spain, Italy, etc and this would surely lead to a breakup of the euro zone.

There are too many headlines in circulation to make any accurate call on oil prices. However, I have seen/heard/read quite a few analysts over the last week who believe now is the time to initiate new oil positions. They warn that oil prices could drop into the $70s temporarily but the long term view remains significantly higher. Boone Pickens, Jim Rogers and some analyst from Goldman whose name I can't remember were talking up oil prices this week just to name a few. Let's hope they are right. I am working on a paper on oil depletion in the shale oil fields to be published in the next couple weeks and the outlook is far from bullish. It is actually frightening. This entire shale oil boom could turn into a bust very quickly if the pace of drilling does not continue to increase. More on this later.